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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 


 

FORM 10-Q

 


 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended June 30, 2004

 

OR

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Transition Period from              to             

 

Commission File Number 0-24612

 


 

ADTRAN, INC.

(Exact name of Registrant as specified in its charter)

 


 

Delaware   63-0918200
(State of Incorporation)  

(I.R.S. Employer

Identification No.)

 

901 Explorer Boulevard, Huntsville, Alabama 35806-2807

(Address of principal executive offices, including zip code)

 

(256) 963-8000

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date:

 

Class


     

Outstanding at July 31, 2004


Common Stock, $.01 Par Value           79,651,876 shares

 



Table of Contents

ADTRAN, INC.

 

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2004

 

Table of Contents

 

Item
Number


        Page
Number


     PART I. FINANCIAL INFORMATION     

1

   Financial Statements:     
     Consolidated Balance Sheets as of June 30, 2004 (Unaudited) and December 31, 2003    3
     Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003 – (Unaudited)    4
     Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003 – (Unaudited)    5
     Notes to Consolidated Financial Statements – (Unaudited)    6

2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    14

3

   Quantitative and Qualitative Disclosures About Market Risk    24

4

   Controls and Procedures    24
     PART II. OTHER INFORMATION     

2

   Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities    24

4

   Submission of Matters to a Vote of Security Holders    25

6

   Exhibits and Reports on Form 8-K    25
     SIGNATURE    26
     EXHIBIT INDEX    27

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

ADTRAN, INC.

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

    

June 30,

2004


    December 31,
2003


     (Unaudited)      

ASSETS

              

Current assets

              

Cash and cash equivalents

   $ 230,904     $ 132,072

Short-term investments

     15,037       11,865

Accounts receivable, less allowance for doubtful accounts of $2,702 and $1,746 at June 30, 2004 and December 31, 2003, respectively

     69,657       52,384

Other receivables

     7,273       6,988

Income tax receivable

     —         11,586

Inventory, net

     43,649       39,975

Prepaid expenses

     2,673       2,127

Deferred tax assets

     4,718       3,381
    


 

Total current assets

     373,911       260,378
    


 

Property, plant and equipment, net

     93,053       97,667

Other assets

     496       493

Long-term investments

     144,269       233,734
    


 

Total assets

   $ 611,729     $ 592,272
    


 

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Current liabilities

              

Accounts payable

   $ 26,024     $ 24,821

Unearned revenue

     2,597       3,209

Accrued expenses

     3,367       2,476

Accrued payroll

     7,453       9,658

Income tax payable

     2,423       145
    


 

Total current liabilities

     41,864       40,309
    


 

Deferred tax liabilities

     2,980       7,254

Other non-current liabilities

     1,544       888

Bonds payable

     50,000       50,000
    


 

Total liabilities

     96,388       98,451
    


 

Commitments and contingencies (see Note 11)

              

Stockholders’ equity

              

Common stock, par value $0.01 per share; 200,000 shares authorized; 79,634 and 79,294 shares issued at June 30, 2004 and December 31, 2003, respectively

     796       793

Additional paid-in capital

     142,764       135,814

Accumulated other comprehensive income

     7,860       10,012

Retained earnings

     376,292       347,202

Less treasury stock at cost: 497 at June 30, 2004

     (12,371 )     —  
    


 

Total stockholders’ equity

     515,341       493,821
    


 

Total liabilities and stockholders’ equity

   $ 611,729     $ 592,272
    


 

 

See notes to consolidated financial statements

 

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Table of Contents

ADTRAN, INC.

 

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)

 

     Three Months Ended
June 30,


   

Six Months Ended

June 30,


 
     2004

    2003

    2004

    2003

 

Sales

   $ 120,601     $ 90,437     $ 234,640     $ 176,659  

Cost of sales

     50,840       40,737       99,361       79,886  
    


 


 


 


Gross profit

     69,761       49,700       135,279       96,773  
    


 


 


 


Selling, general and administrative expenses

     23,984       20,346       46,254       40,503  

Research and development expenses

     15,896       13,639       30,713       27,909  
    


 


 


 


Operating income

     29,881       15,715       58,312       28,361  
    


 


 


 


Interest income

     1,862       2,178       4,060       4,646  

Interest expense

     (644 )     (660 )     (1,288 )     (1,319 )

Net realized investment gain (loss)

     71       225       (55 )     226  

Other income (expense), net

     530       504       891       893  
    


 


 


 


Income before provision for income taxes

     31,700       17,962       61,920       32,807  
    


 


 


 


Provision for income taxes

     (10,302 )     (5,583 )     (20,124 )     (9,889 )
    


 


 


 


Net income

   $ 21,398     $ 12,379     $ 41,796     $ 22,918  
    


 


 


 


Weighted average shares outstanding

     79,313       76,037       79,405       75,618  

Weighted average shares outstanding assuming dilution (1)

     82,221       79,899       82,517       79,019  

Earnings per common share – basic

   $ 0.27     $ 0.16     $ 0.53     $ 0.30  

Earnings per common share – assuming dilution (1)

   $ 0.26     $ 0.15     $ 0.51     $ 0.29  

Dividends per share (2)

   $ 0.08     $ 0.00     $ 0.16     $ 0.00  
    


 


 


 



(1) Assumes exercise of dilutive stock options calculated under the treasury stock method.
(2) During the three and six months ended June 30, 2004, ADTRAN declared and paid a quarterly dividend of $0.08 and $0.16 per common share, respectively.

 

See notes to consolidated financial statements

 

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ADTRAN, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

    

Six Months Ended

June 30,


 
     2004

    2003

 

Cash flows from operating activities:

                

Net income

   $ 41,796     $ 22,918  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation

     7,380       7,722  

(Gain) loss on sale of long-term investments

     55       (226 )

Loss on sale of property, plant and equipment

     7       5  

Deferred income taxes

     (4,573 )     313  

Income tax benefit from exercise of non-qualified stock options

     2,520       —    

Changes in operating assets and liabilities:

                

Accounts receivable, net

     (17,273 )     (12,104 )

Other receivables

     (285 )     1,538  

Income tax receivable

     11,586       —    

Inventory, net

     (3,674 )     612  

Prepaid expenses and other assets

     (548 )     523  

Accounts payable

     1,203       1,753  

Accrued expenses and other liabilities

     (1,270 )     910  

Income tax payable

     2,277       (3,510 )
    


 


Net cash provided by operating activities

     39,201       20,454  
    


 


Cash flows from investing activities:

                

Purchases of property, plant and equipment

     (2,807 )     (2,390 )

Proceeds from disposition of property, plant and equipment

     34       7  

Proceeds from maturities of held-to-maturity investments

     2,000       5,598  

Purchases of held-to-maturity investments

     —         (7,433 )

Proceeds from sales of available-for-sale investments

     81,500       49,211  

Purchases of available-for-sale investments

     (81 )     (85,365 )
    


 


Net cash provided by (used in) investing activities

     80,646       (40,372 )
    


 


Cash flows from financing activities:

                

Proceeds from stock option exercises

     4,433       21,270  

Purchases of treasury stock

     (12,371 )     —    

Dividend payments

     (12,706 )     —    
    


 


Net cash provided by (used in) financing activities

     (20,644 )     21,270  
    


 


Net increase in cash and cash equivalents

     99,203       1,352  

Effect of exchange rate changes

     (371 )     201  

Cash and cash equivalents, beginning of period

     132,072       125,092  
    


 


Cash and cash equivalents, end of period

   $ 230,904     $ 126,645  
    


 


 

See notes to consolidated financial statements

 

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ADTRAN, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except per share amounts)

 

1.    BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements of ADTRAN, Inc. (“ADTRAN”) have been prepared pursuant to the rules and regulations for reporting on Quarterly Reports on Form 10-Q. Accordingly, certain information and notes required by generally accepted accounting principles for complete financial statements are not included herein. In the opinion of management, all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. Certain reclassifications have been made to the 2003 consolidated financial statements in order to conform to the 2004 presentation. These reclassifications had no effect on previously reported net income, cash flows from operations, cash flows from investing activities, or total stockholders’ equity.

 

Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected to occur for the year ending December 31, 2004. The interim statements should be read in conjunction with the financial statements and notes thereto included in ADTRAN’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

On October 13, 2003, the board of directors declared, effective December 15, 2003, a two-for-one stock split to be effected in the form of a stock dividend of one share of common stock for each outstanding share of common stock for stockholders of record on December 1, 2003. Share and per share amounts, including stock options, in the accompanying Consolidated Statements of Income and Notes to Consolidated Financial Statements have been retroactively adjusted to reflect this stock split.

 

2.    INVENTORY

 

At June 30, 2004 and December 31, 2003, inventory consisted of the following:

 

     June 30,
2004


    December 31,
2003


 

Raw materials

   $ 23,291     $ 19,526  

Work in progress

     5,197       3,937  

Finished goods

     18,917       19,614  

Inventory reserve

     (3,756 )     (3,102 )
    


 


Inventory, net

   $ 43,649     $ 39,975  
    


 


 

6


Table of Contents

3.    COMPREHENSIVE INCOME

 

Comprehensive income consists of net income, unrealized foreign currency translation adjustments (net of deferred taxes) and unrealized gains and losses on marketable securities (net of deferred taxes).

 

     Six Months Ended
June 30,


     2004

    2003

Net income

   $ 41,796     $ 22,918

Foreign currency translation gain (loss), net of deferred taxes

     (371 )     201

Change in unrealized gain (loss) on available-for–sale securities, net of deferred taxes

     (1,781 )     1,957
    


 

Total comprehensive income

   $ 39,644     $ 25,076
    


 

 

4.    EARNINGS PER SHARE

 

A summary of the calculation of basic and diluted earnings per share (EPS) for the three and six months ended June 30, 2004 and 2003 is as follows:

 

     For the Three Months Ended June 30, 2004

    

Income

(Numerator)


   Shares
(Denominator)


   Per-Share
Amount


Basic EPS

                  

Income available to common stockholders

   $ 21,398    79,313    $ 0.27

Effect of Dilutive Securities

                  

Stock options

          2,908       

Diluted EPS

                  

Income available to common stockholders plus assumed conversions

   $ 21,398    82,221    $ 0.26

 

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Table of Contents
     For the Six Months Ended June 30, 2004

     Income
(Numerator)


   Shares
(Denominator)


   Per-Share
Amount


Basic EPS

                  

Income available to common stockholders

   $ 41,796    79,405    $ 0.53

Effect of Dilutive Securities

                  

Stock options

          3,112       

Diluted EPS

                  

Income available to common stockholders plus assumed conversions

   $ 41,796    82,517    $ 0.51

 

     For the Three Months Ended June 30, 2003

     Income
(Numerator)


   Shares
(Denominator)


   Per-Share
Amount


Basic EPS

                  

Income available to common stockholders

   $ 12,379    76,037    $ 0.16

Effect of Dilutive Securities

                  

Stock options

          3,862       

Diluted EPS

                  

Income available to common stockholders plus assumed conversions

   $ 12,379    79,899    $ 0.15

 

     For the Six Months Ended June 30, 2003

     Income
(Numerator)


   Shares
(Denominator)


   Per-Share
Amount


Basic EPS

                  

Income available to common stockholders

   $ 22,918    75,618    $ 0.30

Effect of Dilutive Securities

                  

Stock options

          3,401       

Diluted EPS

                  

Income available to common stockholders plus assumed conversions

   $ 22,918    79,019    $ 0.29

 

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The following options were outstanding during the respective periods shown below, but were not included in the computation of that period’s diluted EPS because the options’ exercise prices were greater than the average market price of the common shares shown below, therefore making them anti-dilutive under the treasury method.

 

Outstanding Options

 

Three Months Ended

   Six Months Ended

June 30, 2004

   June 30, 2003

   June 30, 2004

   June 30, 2003

739    118    712    43

 

5.    SEGMENT INFORMATION

 

ADTRAN operates two reportable segments: (1) the Carrier Networks Division and (2) the Enterprise Networks Division. We evaluate the performance of our segments based on gross profit; therefore, selling, general and administrative expenses, as well as research and development expenses, interest income/expense, net realized investment gain/loss, other income/expense, and provision for income taxes are reported on an entity wide basis only. There are no inter-segment revenues.

 

The table below presents information about the reported sales and gross profit of ADTRAN’s segments for the three and six months ended June 30, 2004 and 2003. Asset information by reportable segment is not reported, since ADTRAN does not produce such information internally.

 

     Three Months Ended
June 30, 2004


  

Six Months Ended

June 30, 2004


     Sales

   Gross Profit

   Sales

   Gross Profit

Carrier Networks

   $ 86,624    $ 48,732    $ 164,786    $ 92,541

Enterprise Networks

     33,977      21,029      69,854      42,738
    

  

  

  

Total

   $ 120,601    $ 69,761    $ 234,640    $ 135,279
    

  

  

  

 

     Three Months Ended
June 30, 2003


  

Six Months Ended

June 30, 2003


     Sales

   Gross Profit

   Sales

   Gross Profit

Carrier Networks

   $ 62,105    $ 33,055    $ 119,911    $ 64,190

Enterprise Networks

     28,332      16,645      56,748      32,583
    

  

  

  

Total

   $ 90,437    $ 49,700    $ 176,659    $ 96,773
    

  

  

  

 

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The table below presents sales information by geographic region for the three months and six months ended June 30, 2004 and 2003.

 

Sales by Geographic Region

 

     Three Months Ended

     June 30, 2004

   June 30, 2003

United States

   $ 111,477    $ 85,299

Foreign

     9,124      5,138
    

  

Total

   $ 120,601    $ 90,437
    

  

     Six Months Ended

     June 30, 2004

   June 30, 2003

United States

   $ 220,217    $ 168,231

Foreign

     14,423      8,428
    

  

Total

   $ 234,640    $ 176,659
    

  

 

Sales by Product

 

The Digital Business Transport (DBT)/Total Reach® category is comprised of revenue from ISDN and DDS transport and connectivity products sold to carrier and enterprise customers. The High-bit-rate Digital Subscriber Line (HDSL)/T1 category is comprised of revenue from HDSL related carrier products and T1 CSU/DSU enterprise products. The Systems category includes revenue from Total Access narrow band products, M-13 multiplexers, integrated access devices and new products comprised of NetVanta routers, ethernet switches, internet security products, DSLAM products, and optical access products.

 

The table below presents sales information by product for the three and six months ended June 30, 2004 and 2003.

 

     Three Months Ended

     June 30, 2004

   June 30, 2003

Digital Business Transport (DBT)/Total Reach®

   $ 6,357    $ 8,345

High-bit-rate Digital Subscriber Line (HDSL)/T1

     54,660      43,336

Systems

     59,584      38,756
    

  

Total

   $ 120,601    $ 90,437
    

  

     Six Months Ended

     June 30, 2004

   June 30, 2003

Digital Business Transport (DBT)/Total Reach®

   $ 12,407    $ 16,221

High-bit-rate Digital Subscriber Line (HDSL)/T1

     107,693      90,982

Systems

     114,540      69,456
    

  

Total

   $ 234,640    $ 176,659
    

  

 

6.    LIABILITY FOR WARRANTY RETURNS

 

ADTRAN’s products generally include warranties of one to 10 years for product defects. ADTRAN accrues for warranty returns at the cost to repair or replace the defective products at the time revenue is

 

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recognized. ADTRAN engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers. Our warranty obligation is affected by product failure rates, material usage and other rework costs incurred in correcting a product failure. The liability for warranty returns totaled $1,624 and $1,541 at June 30, 2004 and December 31, 2003, respectively. These liabilities are included in accrued expenses in the accompanying consolidated balance sheets.

 

     Six months ended June 30, 2004

          Additions

          
     Balance at
December 31,
2003


   Charged
(Credited) to
Costs &
Expenses


   Charged
(Credited)
to Other
Accounts


   Deductions

    Balance at
June 30,
2004


Warranty liability

   $ 1,541    $ 1,073    —      $ (990 )   $ 1,624
    

  

  
  


 

 

7.    STOCK-BASED COMPENSATION

 

ADTRAN applies APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option plans. Had compensation cost for ADTRAN’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed in SFAS No. 123, Accounting for Stock-Based Compensation, net income and earnings per share would have been reduced to the pro forma amounts indicated below:

 

Pro Forma Net Income & Earnings Per Share

 

     Three Months Ended

 
     June 30, 2004

    June 30, 2003

 

Net income – as reported

   $ 21,398     $ 12,379  

Less: stock-based compensation expense, net of tax

     (3,405 )     (4,824 )
    


 


Net income – pro forma

   $ 17,993     $ 7,555  
    


 


Earnings per share:

                

Basic-as reported

   $ 0.27     $ 0.16  

Basic-pro forma

   $ 0.23     $ 0.10  

Diluted-as reported

   $ 0.26     $ 0.15  

Diluted-pro forma

   $ 0.22     $ 0.09  
     Six Months Ended

 
     June 30, 2004

    June 30, 2003

 

Net income – as reported

   $ 41,796     $ 22,918  

Less: stock-based compensation expense, net of tax

     (6,811 )     (9,612 )
    


 


Net income – pro forma

   $ 34,985     $ 13,306  
    


 


Earnings per share:

                

Basic-as reported

   $ 0.53     $ 0.30  

Basic-pro forma

   $ 0.44     $ 0.18  

Diluted-as reported

   $ 0.51     $ 0.29  

Diluted-pro forma

   $ 0.42     $ 0.17  

 

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The pro forma amounts reflected above are not representative of the effects on reported net income in future years because, in general, the options granted typically do not vest for several years and additional awards are made each year. The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

     Three Months Ended

    Six Months Ended

 
     June 30, 2004

    June 30, 2003

    June 30, 2004

    June 30, 2003

 

Expected dividend yield

   1.08 %   0 %   0.97 %   0 %

Expected life (years)

   5.00     5.00     5.00     5.00  

Expected volatility

   55.9 %   51.1 %   55.9 %   51.1 %

Risk-free interest rate

   3.45 %   3.20 %   3.25 %   3.20 %

 

8.    STOCKHOLDERS’ EQUITY

 

A summary of the changes in stockholders’ equity for the six months ended June 30, 2004 is as follows:

 

     Stockholders’ Equity

 

Balance, December 31, 2003

   $ 493,821  

Net income

     41,796  

Dividend payments

     (12,706 )

Change in unrealized gain on marketable securities (net of deferred taxes)

     (1,781 )

Unrealized foreign currency translation (net of deferred taxes)

     (371 )

Exercise of stock options

     4,433  

Purchase of treasury stock

     (12,371 )

Income tax benefit from exercise of non-qualified stock options

     2,520  
    


Balance, June 30, 2004

   $ 515,341  
    


 

On January 20, 2004 the board of directors declared a quarterly cash dividend of $0.08 per common share to be paid to stockholders of record at the close of business on February 3, 2004. The payment date of the quarterly dividend was February 17, 2004. The quarterly dividend payment was $6,365.

 

On April 13, 2004 the board of directors declared a quarterly cash dividend of $0.08 per common share to be paid to stockholders of record at the close of business on May 4, 2004. The payment date of the quarterly dividend was May 18, 2004. The quarterly dividend payment was $6,341.

 

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ADTRAN issued 340 shares of common stock to fulfill stock option exercises during the six months ended June 30, 2004. The stock options had exercise prices ranging from $8.70 to $37.18. ADTRAN received proceeds totaling $4,433 from the exercise of these stock options during the six months ended June 30, 2004.

 

ADTRAN repurchased 497 shares of its common stock through open market purchases at a total cost of $12,371 during the six months ended June 30, 2004 and had the authority to purchase an additional 3,827 shares.

 

9.    RECENTLY ISSUED ACCOUNTING STANDARDS

 

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities. In December 2003, the FASB issued FIN 46R (revised December 2003), which replaces FIN 46. FIN 46R clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. FIN 46R is required to be applied to entities that are considered special-purpose entities no later than as of the end of the first reporting period that ends after December 15, 2003 and to entities not considered to be special-purpose entities by March 31, 2004. Since we do not have an interest in any special-purpose entities, or in entities or relationships that meet the definition of a variable interest entity, the accompanying consolidated financial statements were not affected by FIN 46R.

 

10.    RELATED PARTY TRANSACTIONS

 

We employ the law firm of one of our directors emeritus for legal services. All bills for services rendered by this firm are reviewed and approved by our chief financial officer. We believe that the fees for such services are comparable to those charged by other firms for services rendered to us. We paid $60 and $50 during the six months ended June 30, 2004 and 2003, respectively, for legal services rendered.

 

One of our non-employee directors is the President – Customer Markets, of one of our significant customers who is also a vendor. In the normal course of business, we receive payments from and make payments to this customer. For the six months ended June 30, 2004 and 2003 we received payments, directly and indirectly, from this customer in the amount of approximately $12,700 and $13,400, respectively, for products supplied to this customer. In addition, for the six months ended June 30, 2004 and 2003 we paid to this customer $323 and $253, respectively, for services provided to us.

 

11.    COMMITMENTS AND CONTINGENCIES

 

We have certain contingent liabilities resulting from litigation or other matters arising in the normal course of business. Although the outcome of any litigation and other matters can never be certain, it is our opinion that the outcome of such contingencies will not materially affect our business, operations, financial condition or cash flows.

 

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During the six months ended June 30, 2004, there have been no material changes in contractual obligations and commercial commitments from those discussed in our most recent Form 10-K filed on March 12, 2004. We do not have off-balance sheet financing arrangements and have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources. We have committed to invest up to an aggregate of $7,900 in two private equity funds, of which $2,000 has been invested to date. The duration of each of these commitments is five years with $2,900 expiring in 2005 and $5,000 expiring in 2007.

 

12.    SUBSEQUENT EVENTS

 

On July 12, 2004 ADTRAN announced that its board of directors declared a quarterly cash dividend of $0.08 per common share to be paid to stockholders of record at the close of business on August 3, 2004. The payment date will be August 17, 2004. The quarterly dividend payment will be approximately $6,400. The board of directors presently anticipates that it will declare a regular quarterly dividend so long as the present tax treatment of dividends exists and adequate levels of liquidity are maintained.

 

During July 2004, ADTRAN repurchased 927 shares of its common stock at an average price of $25.01 through open market purchases.

 

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD LOOKING STATEMENTS

 

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of ADTRAN. ADTRAN and its representatives may from time to time make written or oral forward-looking statements, including statements contained in this report, our other filings with the Securities and Exchange Commission and in our reports to our stockholders. Generally, the words, “believe,” “expect,” “intend,” “estimate,” “anticipate,” “will,” “may,” “could” and similar expressions identify forward-looking statements. We caution you that any forward-looking statements made by us or on our behalf are subject to uncertainties and other factors that could cause such statements to be wrong. Some of these uncertainties and other factors are listed below. They have been discussed in our most recent Form 10-K filed on March 12, 2004 with the SEC. Though we have attempted to list comprehensively these important factors, we caution investors that other factors may prove to be important in the future in affecting our operating results. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or combination of factors may have on our business.

 

You are further cautioned not to place undue reliance on these forward-looking statements because they speak only of our views as of the date that the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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The following are some of the risks that could affect our financial performance or could cause actual results to differ materially from those expressed or implied in our forward-looking statements:

 

We must continue to update and improve our products and develop new products in order to compete and to keep pace with improvements in telecommunications technology.

 

We do not engage in long-term research and development processes, and as a consequence may miss certain market opportunities enjoyed by larger companies with substantially greater research and development efforts.

 

Our dependence on a limited number of suppliers may prevent us from delivering our products on a timely basis, which could have a material adverse effect on customer relations and operating results.

 

Our dependence on subcontractors may result in reduced control over product quality, delayed delivery of products, increased material cost from excess/obsolete material, and/or increased manufacturing costs, each of which could negatively affect customer relations and operating results.

 

We compete in markets that have become increasingly competitive, which may result in reduced gross profit margins and market share.

 

We depend heavily on sales to certain customers; the loss of any of these customers would significantly reduce our revenues and net income.

 

The lengthy approval process required by Incumbent Local Exchange Carriers (ILECs) and other carriers could result in fluctuations in our revenues.

 

Consolidation and deterioration in the competitive service provider market could result in a significant decrease in our revenue.

 

Increased sales volume in international markets could result in increased costs or loss of revenue due to factors inherent in these markets.

 

Our success depends on our ability to reduce the selling prices of succeeding generations of our products.

 

Our failure to maintain rights to intellectual property used in our business could adversely affect the development, functionality and commercialization of our products.

 

Our success depends on attracting and retaining key personnel.

 

The price of our common stock has been volatile and may continue to fluctuate significantly.

 

The foregoing list of risks is not exclusive.

 

OVERVIEW

 

ADTRAN designs, develops, manufactures, markets, and services a broad range of high-speed network access products utilized by providers of telecommunications services and enterprise end-users. We currently sell our products to a large number of carriers, including all Regional Bell Operating Companies (RBOCs), and to private and public enterprises worldwide.

 

Sales and earnings continue to grow due to our strategy of increasing unit volume and market share through the introduction of new products and succeeding generations of products having lower selling prices and increased functionality as compared to both the prior generation of a product and to the products of competitors. An important part of ADTRAN’s strategy is to reduce the cost of each succeeding product generation and then to lower the product’s selling price based on the cost savings achieved. As a part of this strategy, we seek to be a high-quality, low-cost provider of products in our markets. ADTRAN’s success to date is attributable in large measure to our ability to design our products initially with a view to their subsequent redesign, allowing both increased functionality and reduced manufacturing costs in each succeeding product generation. This strategy enables ADTRAN to sell succeeding generations of products to existing customers, while increasing our market share by selling these enhanced products to new customers.

 

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Our sales and earnings increased from the second quarter of 2003 to the second quarter of 2004. The quarter-over-quarter increase in sales and earnings is attributable to an increase in sales of our Systems products and HDSL/ T1 products. The continuing increase in Systems revenue is attributable to increasing sales of new products comprised of DSLAMs, optical access products and NetVanta products. Additionally, the increase in Systems revenue is attributable to continuing increases in sales of our Integrated Access Devices. The quarter-over-quarter increase in HDSL/ T1 revenue is primarily attributable to increasing Carrier Networks sales of our HDSL based Total Access 3000 broadband platform.

 

Our operating results have fluctuated on a quarterly basis in the past, and operating results may vary significantly in future periods due to a number of factors. We normally operate with very little order backlog. A majority of our sales in each quarter result from orders booked in that quarter and firm purchase orders released in that quarter by customers under agreements containing non-binding purchase commitments. Furthermore, a majority of customers typically require prompt delivery of products. This results in a limited backlog of orders for these products and requires us to maintain sufficient inventory levels to satisfy anticipated customer demand. If near-term demand for ADTRAN’s products declines, or if potential sales in any quarter do not occur as anticipated, our financial results could be adversely affected. Operating expenses are relatively fixed in the short term; therefore, a shortfall in quarterly revenues could significantly impact ADTRAN’s financial results in a given quarter. Further, maintaining sufficient inventory levels to assure prompt delivery of our products increases the amount of inventory which may become obsolete and increases the risk that the obsolescence of such inventory may have an adverse effect on our business and operating results.

 

ADTRAN’s operating results may also fluctuate as a result of a number of other factors, including increased competition, customer order patterns, changes in product mix, timing differences between price decreases and product cost reductions, product warranty returns, and announcements of new products by ADTRAN or our competitors. Accordingly, ADTRAN’s historical financial performance is not necessarily a meaningful indicator of future results, and, in general, management expects that ADTRAN’s financial results may vary from period to period.

 

CRITICAL ACCOUNTING POLICIES

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements. These policies have been consistently applied across our two reportable segments: (1) Carrier Networks Division and (2) Enterprise Networks Division.

 

We review customer contracts to determine if all of the requirements for revenue recognition have been met prior to recording revenues from sales transactions. We generally record sales revenue upon shipment of our products, net of any discounts, since: (i) we generally do not have significant post-delivery obligations, (ii) the product price is fixed and determinable, (iii) collection of the resulting receivable is probable, and (iv) product returns are reasonably estimable. We generally ship products upon receipt of a purchase order from a customer. We evaluate shipping terms and we record revenue on products shipped in accordance with the applicable terms of each respective contract. We defer revenue on customer billings for our maintenance service programs that are paid up front. We currently offer one-year, three-year, and five-year maintenance contracts, primarily on Enterprise Networks Division products sold through distribution channels. Revenue attributable to these maintenance contracts is recognized ratably on a straight-line basis over the related contract. Current deferred revenue items are included in the current liabilities section of the accompanying consolidated balance sheets as unearned revenue. Long-term deferred revenue items are included in other non-current liabilities in the accompanying consolidated balance sheets.

 

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   We participate in cooperative advertising and market development programs with certain customers. We use these programs to reimburse customers for certain forms of advertising, and in general, to allow our customers credits up to a specified percentage of their net purchases. Our costs associated with these programs are estimated and accrued at the time of sale and are included in marketing expenses in our consolidated statements of income. We also participate in rebate programs to provide sales incentives for certain products. Our costs associated with these programs are estimated and accrued at the time of sale, and are recorded as a reduction of sales in our consolidated statements of income. Sales returns are accrued based on historical sales return experience, which we believe provides a reasonable estimate of future returns. Product returns are generally limited to customers who purchase our products under specific sales agreements that govern their rights of return.

 

   Prior to accepting a new customer, we perform a detailed credit review of the customer. Credit limits are established for each new customer based on the results of this credit review. Payment terms are established for each new customer, and collection experience is reviewed periodically in order to determine if the customer’s payment terms and credit limits need to be revised. We maintain allowances for doubtful accounts for losses resulting from the inability of our customers to make required payments. If the financial conditions of our customers were to deteriorate, resulting in an impairment of their ability to make payments, we might be required to make additional allowances. If circumstances change with regard to individual receivable balances that had previously been determined to be uncollectible (and for which a specific reserve had been established), a reduction in our allowance for doubtful accounts may be required. Our allowance for doubtful accounts was $2.7 million and $1.7 million at June 30, 2004 and December 31, 2003, respectively.

 

We carry our inventory at the lower of cost or market, with cost being determined using the first-in, first-out method. We use standard costs for material, labor, and manufacturing overhead to value our inventory. Our standard costs are updated on a monthly basis and any variances are accounted for in the current period. Therefore, our inventory costs approximate actual costs at the end of each reporting period. We write-down our inventory for estimated obsolescence or unmarketable inventory by an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, we may be required to make additional inventory write-downs. Our reserve for excess and obsolete inventory was $3.8 million and $3.1 million at June 30, 2004 and December 31, 2003, respectively.

 

The objective of our short-term investment policy is to preserve principal and maintain adequate liquidity with appropriate diversification, while emphasizing market returns on our monetary assets. The objective of our long-term investment policy is to emphasize total return; that is, the aggregate return from capital appreciation, dividend income, and interest income. This is achieved through investments with appropriate diversification in fixed and variable rate income, public equity, and private equity portfolios. We have experienced significant volatility in the market prices of our publicly traded equity investments. These investments are recorded on the consolidated balance sheets at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income (loss), net of tax. The ultimate realized value on these equity investments is subject to market price volatility until they are sold.

 

   We review our investment portfolio for potential “other-than-temporary” declines in value on an individual investment basis. We assess, on a quarterly basis, significant declines in value which may be considered other-than-temporary and, if necessary, recognize and record the appropriate charge to write-down the carrying value of such investments. In making this assessment, we take into consideration a wide range of objective and subjective information, including but not limited to the following: the magnitude and duration of historical decline in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a market value that has declined from its original or adjusted cost basis by 25% for more than six months. We

 

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   then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. Actual losses, if any, could ultimately differ from these estimates. Future adverse changes in market conditions or poor operating results of underlying investments could result in additional losses that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.

 

   We also invest in privately held entities and record our investments in these entities at cost. We review our investments in these entities periodically in order to determine if circumstances (both financial and non-financial) exist that indicate that we will not recover our initial investment. Impairment charges are recorded on investments having a cost basis that is greater than the value that we would reasonably expect to receive in an arm’s length sale of the investment.

 

We estimate our income tax provision or benefit in each of the jurisdictions in which we operate, including estimating exposures related to examinations by taxing authorities. We must also make judgements regarding the realization of deferred tax assets. The carrying value of our net deferred tax assets is based on our belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets. A valuation allowance has been established for deferred tax assets which we do not believe meet the more-likely-than-not criteria established by SFAS No. 109, Accounting for Income Taxes. Our estimates regarding future taxable income and income tax provision or benefit may vary due to changes in market conditions, changes in tax laws, or other factors. If our assumptions, and consequently our estimates, change in the future, the valuation allowances we have established may be increased or decreased, impacting future income tax expense.

 

We estimate our cost to repair or replace defective products at the time revenue is recognized and include this cost in cost of goods sold in our consolidated statements of income. Our products generally include warranties of one to 10 years for product defects. The liability for warranty returns totaled $1.6 million and $1.5 million at June 30, 2004 and December 31, 2003, respectively. These liabilities are included in accrued expenses in the accompanying consolidated balance sheets. Our estimates regarding future warranty obligations may change due to product failure rates, shipment volumes, and other rework costs incurred in correcting a product failure. If our estimates change in the future, the liability for warranty returns we have established may be increased or decreased, impacting future cost of goods sold.

 

RESULTS OF OPERATIONS – THREE AND SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE AND SIX MONTHS ENDED JUNE 30, 2003

 

SALES

 

ADTRAN’s sales increased 33.4% from $90.4 million in the three months ended June 30, 2003 to $120.6 million in the three months ended June 30, 2004. Sales increased 32.8% from $176.7 million in the six months ended June 30, 2003 to $234.6 million in the six months ended June 30, 2004. The increase is primarily the result of increasing unit volume and market share gains. In particular, the increase in overall sales is attributable to an increase in sales of our Systems products and High-bit-rate Digital Subscriber Line (HDSL)/T1 products, partially offset by decreased sales of our Digital Business Transport (DBT)/Total Reach products. The increase in Systems revenue is attributable to sales of DSLAMs, Integrated Access Devices, optical access products and NetVanta products. The increase in HDSL/ T1 revenue is primarily attributable to increasing Carrier Networks sales of our HDSL based Total Access 3000 broadband platform.

 

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Carrier Networks sales increased 39.5% from $62.1 million in the three months ended June 30, 2003 to $86.6 million in the three months ended June 30, 2004 and increased 37.4% from $119.9 million in the six months ended June 30, 2003 to $164.8 million in the six months ended June 30, 2004. The increase in Carrier Networks sales is primarily attibutable to new product acceptance of and market share gains in DSLAMs and optical access products. Carrier Networks sales as a percentage of total sales increased from 68.7% in the three months ended June 30, 2003 to 71.8% in the three months ended June 30, 2004 and increased from 67.9% in the six months ended June 30, 2003 to 70.2% in the six months ended June 30, 2004.

 

Enterprise Networks sales increased 20.1% from $28.3 million in the three months ended June 30, 2003 to $34.0 million in the three months ended June 30, 2004 and increased 23.3% from $56.7 million in the six months ended June 30, 2003 to $69.9 million in the six months ended June 30, 2004. The increase in Enterprise Networks sales is primarily attributable to new product acceptance of and market share gains in Integrated Access Devices and NetVanta products. Enterprise Networks sales as a percentage of total sales decreased from 31.3% for the three months ended June 30, 2003 to 28.2% for the three months ended June 30, 2004 and decreased from 32.1% for the six months ended June 30, 2003 to 29.8% for the six months ended June 30, 2004.

 

Foreign sales increased 78.4% from $5.1 million in the three months ended June 30, 2003 to $9.1 million in the three months ended June 30, 2004 and increased 71.4% from $8.4 million in the six months ended June 30, 2003 to $14.4 million in the six months ended June 30, 2004. The increase in foreign sales is attributable to an overall increase in demand in Australia and Canada.

 

COST OF SALES

 

As a percentage of sales, cost of sales decreased from 45.0% in the three months ended June 30, 2003 to 42.2% in the three months ended June 30, 2004 and decreased from 45.2% in the six months ended June 30, 2003 to 42.3% in the six months ended June 30, 2004. This decrease in cost of sales as a percentage of sales is primarily related to manufacturing efficiencies, the timing differences between the recognition of cost reductions and the lowering of product selling prices and the sales of higher margin new products.

 

Carrier Networks cost of sales, as a percent of division sales, decreased from 46.8% in the three months ended June 30, 2003 to 43.7% in the three months ended June 30, 2004 and decreased from 46.5% in the six months ended June 30, 2003 to 43.8% in the six months ended June 30, 2004. Enterprise Networks cost of sales, as a percent of division sales, decreased from 41.3% in the three months ended June 30, 2003 to 38.1% in the three months ended June 30, 2004 and decreased from 42.6% in the six months ended June 30, 2003 to 38.8% in the six months ended June 30, 2004.

 

An important part of ADTRAN’s strategy is to reduce the product cost of each succeeding product generation and then to lower the product’s price based on the cost savings achieved. This strategy, as described above, sometimes results in variations in ADTRAN’s gross profit margin from quarter to quarter due to timing differences between the recognition of cost reductions and the lowering of product selling prices. In view of the rapid pace of new product introductions by ADTRAN, it is difficult to predict the gross margin for any particular financial period.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

Selling, general and administrative expenses increased 18.2% from $20.3 million in the three months ended June 30, 2003 to $24.0 million in the three months ended June 30, 2004 and increased 14.3% from $40.5 million in the six months ended June 30, 2003 to $46.3 million in the six months ended June 30, 2004. The increase in selling, general and administrative expenses is primarily related to the increase in sales, commissions, annual merit increases and an increase in bad debt expense. ADTRAN recorded $977 thousand of bad debt expense in the three months ended June 30, 2004 primarily related to financial difficulties at one of our customers.

 

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Selling, general and administrative expenses as a percentage of sales decreased from 22.5% in the three months ended June 30, 2003 to 19.9% in the three months ended June 30, 2004 and decreased from 22.9% in the six months ended June 30, 2003 to 19.7% in the six months ended June 30, 2004. The decrease in selling, general and administrative expenses as a percent of sales is due to our continued control of discretionary spending as sales increased. Selling, general and administrative expenses as a percent of sales will fluctuate whenever there is a significant fluctuation in revenues during the periods being compared.

 

RESEARCH AND DEVELOPMENT EXPENSES

 

Research and development expenses increased 16.9% from $13.6 million in the three months ended June 30, 2003 to $15.9 million in the three months ended June 30, 2004 and increased 10.0% from $27.9 million in the six months ended June 30, 2003 to $30.7 million in the six months ended June 30, 2004. The increase in research and development expense is primarily related to an increase in lab acceptance testing and new product development activities. As a percentage of sales, research and development expenses decreased from 15.1% in the three months ended June 30, 2003 to 13.2% in the three months ended June 30, 2004 and decreased from 15.8% in the six months ended June 30, 2003 to 13.1% in the six months ended June 30, 2004. The decrease in research and development expenses as a percent of sales is due to our continued control of discretionary spending as sales increased. Research and development expenses as a percent of sales will fluctuate whenever there is a significant fluctuation in revenues during the periods being compared.

 

ADTRAN will continue to incur research and development expenses in connection with its new products and its expansion into international markets. ADTRAN continually evaluates new product opportunities and engages in intensive research and product development efforts. ADTRAN expenses all product research and development costs as incurred. As a result, ADTRAN may incur significant research and development expenses prior to the receipt of revenues from a major new product group.

 

INTEREST INCOME

 

Interest income decreased 13.6% from $2.2 million in the three months ended June 30, 2003 to $1.9 million in the three months ended June 30, 2004 and decreased 10.9% from $4.6 million in the six months ended June 30, 2003 to $4.1 million in the six months ended June 30, 2004. This decrease is primarily related to lower interest rates associated with shorter-term securities in our investment portfolio.

 

INTEREST EXPENSE

 

Interest expense remained relatively stable at $644 thousand and $660 thousand in the three months ended June 30, 2004 and 2003, respectively, and remained stable at $1.3 million in each of the six months ended June 30, 2004 and June 30, 2003.

 

NET REALIZED INVESTMENT GAIN (LOSS)

 

Net realized investment gain (loss) changed from a net gain of $225 thousand in the three months ended June 30, 2003 to a net gain of $71 thousand in the three months ended June 30, 2004 and changed from a net gain of $226 thousand in the six months ended June 30, 2003 to a net loss of $55 thousand in the six months ended June 30, 2004.

 

OTHER INCOME

 

Other income, comprised primarily of miscellaneous income, gains and losses on foreign currency transactions and scrap raw material sales, increased from $504 thousand in the three months ended June 30, 2003 to $530 thousand in the three months ended June 30, 2004 and decreased from $893 thousand in the six months ended June 30, 2003 to $891 thousand in the six months ended June 30, 2004.

 

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INCOME TAXES

 

Our effective tax rate increased from 31.1% in the three months ended June 30, 2003 to 32.5% in the three months ended June 30, 2004 and increased from 30.1% in the six months ended June 30, 2003 to 32.5% in the six months ended June 30, 2004. This increase is primarily related to a higher mix of taxable income and lower research and development tax credits and economic incentive credits as a percent of taxable income.

 

NET INCOME

 

As a result of the above factors, net income increased $9.0 million from $12.4 million in the three months ended June 30, 2003 to $21.4 million in the three months ended June 30, 2004 and increased $18.9 million from $22.9 million in the six months ended June 30, 2003 to $41.8 million in the six months ended June 30, 2004. As a percentage of sales, net income increased from 13.7% in the three months ended June 30, 2003 to 17.7% in the three months ended June 30, 2004 and increased from 13.0% in the six months ended June 30, 2003 to 17.8% in the six months ended June 30, 2004.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Fifty million dollars of the expansion of Phase III of our corporate headquarters was approved for participation in an incentive program offered by the Alabama State Industrial Development Authority (the “Authority”). Pursuant to the program, on January 13, 1995, the Authority issued $20.0 million of its taxable revenue bonds and loaned the proceeds from the sale of the bonds to ADTRAN. The bonds were originally purchased by AmSouth Bank of Alabama, Birmingham, Alabama, (the “Bank”). First Union National Bank of Tennessee, Nashville, Tennessee, (the “Bondholder”) purchased the original bonds from the Bank and made further advances to the Authority, bringing the total amount outstanding to $50.0 million.The incentive program enables participating companies to generate Alabama corporate income tax credits that can be used to reduce the amount of Alabama corporate income taxes that would otherwise be payable. We cannot be certain that the state of Alabama will continue to make these corporate income tax credits available in the future, and therefore, we may not realize the full benefit of these incentives. Through June 30, 2004, the Authority had issued $50.0 million of its taxable revenue bonds pursuant to the incentive program and loaned the proceeds from the sale of the bonds to ADTRAN. We are required to make payments to the Authority in the amounts necessary to pay the principal of and interest on the Authority’s Taxable Revenue Bond, Series 1995, as amended, currently outstanding in the aggregate principal amount of $50.0 million. The bond matures on January 1, 2020, and bears interest at the rate of 5%. Included in long-term investments are $50.0 million of restricted funds, which is a collateral deposit against the principal amount of this bond. In conjunction with this program, we are eligible to receive certain economic incentives from the state of Alabama that reduce the amount of payroll withholdings that we are required to remit to the state for those employment positions that qualify under the program.

 

In July 2003, the board of directors elected to begin declaring quarterly dividends on our common stock, and anticipates that it will declare a regular quarterly dividend so long as the present tax treatment of dividends exists and adequate levels of liquidity are maintained. The board declared a quarterly cash dividend on January 20, 2004. The quarterly cash dividend was $0.08 per common share to be paid to holders of record at the close of business on February 3, 2004, with a payment date of February 17, 2004. The quarterly dividend payment was approximately $6.4 million. On April 13, 2004, the board of directors declared a quarterly cash dividend of $0.08 per common share to be paid to stockholders of record at the close of business on May 4, 2004. The quarterly dividend payment was approximately $6.4 million. On July 12, 2004, the board of directors declared a quarterly cash dividend of $0.08 per common share to be paid to stockholders of record at the close of business on August 3, 2004. The payment date will be August 17, 2004. The quarterly dividend payment will be approximately $6.4 million.

 

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On October 13, 2003, we announced that our board of directors declared, effective December 15, 2003, a two-for-one stock split to be effected in the form of a stock dividend of one share of common stock for each outstanding share of common stock for stockholders of record on December 1, 2003. Share and per share amounts, including stock options, in the accompanying Consolidated Financial Statements and Notes to Consolidated Financial Statements have been adjusted to reflect this stock split.

 

Our working capital, which consists of current assets less current liabilities, increased 50.8% from $220.1 million as of December 31, 2003 to $332.0 million as of June 30, 2004. The quick ratio, defined as cash, cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, increased from 4.87 as of December 31, 2003 to 7.54 as of June 30, 2004. The current ratio, defined as current assets divided by current liabilities, increased from 6.46 as of December 31, 2003 to 8.93 as of June 30, 2004. The increase in the liquidity ratios is primarily related to increases in cash and cash equivalents, short-term investments, accounts receivable and inventory. The increase in cash and cash equivalents and the corresponding decrease in long term investments is primarily related to the continued shortening of the average life of the investments in our investment portfolio. Additionally, the liquidity ratios were also effected by the change in income tax position during the first quarter of 2004. As of December 31, 2003, we had an income tax receivable of $11.6 million and at June 30, 2004 we had an income tax payable of $2.4 million. The income tax receivable was generated in the fourth quarter of 2003 from the tax benefit associated with the exercise of non-qualified stock options. During the first quarter of 2004, we received a tax refund for this overpayment.

 

We receive an income tax deduction for the difference between the exercise price and the market price of non-qualified stock options upon exercise by employees. We recorded $2.5 million and $23.6 million during the six months ended June 30, 2004 and the year ended December 31, 2003, respectively, as an income tax deduction for the difference between the exercise price and the market price of non-qualified stock option exercises.

 

At June 30, 2004, our cash on hand of $230.9 million and short-term investments of $15.0 million placed our short-term liquidity in cash, cash equivalents, and short-term investments at $245.9 million. At December 31, 2003, our cash on hand of $132.1 million and short-term investments of $11.9 million placed our short-term liquidity in cash, cash equivalents, and short-term investments at $144.0 million. This increase is primarily attributable to our ability to generate cash from operations, the sale of long-term investments and the purchase of short-term bonds, the movement of bonds maturing within one year from long-term investments to short-term investments, and the proceeds received from the exercise of employee stock options.

 

At June 30, 2004, our long-term investments decreased by 38.3% to $144.3 million from $233.7 million at December 31, 2003. This decrease is primarily attributable the sale of long-term investments, and the movement of bonds maturing within one year from long-term investments to short-term investments. Long-term investments at June 30, 2004, and December 31, 2003, include a restricted balance of $50.0 million related to our revenue bonds, as discussed above. We intend to finance our operations in the future with cash flow from operations and our remaining borrowed taxable revenue bond proceeds. We believe these available sources of funds to be adequate to meet our operating and capital needs for the foreseeable future. Net accounts receivable increased 33.0% from December 31, 2003 to June 30, 2004. Quarterly accounts receivable days sales outstanding increased 11 days from 42 days as of December 31, 2003 to 53 days as of June 30, 2004. This increase in accounts receivable and quarterly accounts receivable days sales outstanding is caused by seasonality of sales. Other receivables decreased 4.1% from December 31, 2003 to June 30, 2004, primarily resulting from variations of timing of payments from subcontractors. Quarterly inventory turnover decreased from 4.86 turns as of December 31, 2003 to 4.62 turns as of June 30, 2004. The decrease in inventory turnover is attributable to an increase in inventory in anticipation of increased sales.

 

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Accounts payable increased 4.8% from December 31, 2003 to June 30, 2004. Accrued expenses increased 36.0% from December 31, 2003 to June 30, 2004. These increases are primarily related to the variations of timing of payments, increased business activity, and a net increase in our warranty reserve related to the expanding base of ADTRAN products in the field under warranty. Capital expenditures totaled approximately $2.8 million and $2.4 million for the six months ended June 30, 2004 and 2003, respectively. These expenditures were primarily used to purchase computer hardware, computer software, manufacturing equipment, and test equipment.

 

In July 2001, the board of directors approved the repurchase of 2 million shares of ADTRAN common stock on a pre-split basis. The total number of shares authorized were not effected by the stock split. During April 2004, with the purchase of 323,400 shares, we completed our July 2001 share repurchase plan at a total cost for the plan of $39.7 million.

 

On April 29, 2004 the board of directors approved the repurchase of up to 4 million shares of ADTRAN common stock through open market purchases from time to time as conditions warrant. As of June 30, 2004, we had repurchased 173,500 shares of our common stock at a total cost of $4.3 million and had the authority to purchase an additional 3,826,500 shares.

 

We issued 340,052 shares of common stock for $4.4 million during the six months ended June 30, 2004, to accommodate employee stock option exercises. During 2003, we issued 4,529,271 shares of common stock, of which 4,125,242 shares were treasury stock, to accommodate employee stock option exercises.

 

We have used, and expect to continue to use, the cash generated from operations for working capital, dividend payments, and other general corporate purposes, including (i) product development activities to enhance our existing products and develop new products and (ii) expansion of sales and marketing activities.

 

During the six months ended June 30, 2004, there have been no material changes in contractual obligations and commercial commitments from those discussed in our most recent Form 10-K filed on March 12, 2004. We do not have off-balance sheet financing arrangements and have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources. We have committed to invest up to an aggregate of $7.9 million in two private equity funds, of which $2.0 million has been invested to date. The duration of each of these commitments is five years with $2.9 million expiring in 2005 and $5.0 million expiring in 2007.

 

EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS

 

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities. In December 2003, the FASB issued FIN 46R (revised December 2003), which replaces FIN 46. FIN 46R clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. FIN 46R is required to be applied to entities that are considered special-purpose entities no later than as of the end of the first reporting period that ends after December 15, 2003 and to entities not

 

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considered to be special-purpose entities by March 31, 2004. Since we do not have an interest in any special-purpose entities or in entities or relationships that meet the definition of a variable interest entity, the accompanying consolidated financial statements were not affected by FIN 46R.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

ADTRAN has not conducted transactions, established commitments or entered into relationships requiring disclosures beyond those provided elsewhere in this Form 10-Q.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of disclosure controls and procedures. Our chief executive officer and chief financial officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for the company. Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are adequate and effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic SEC filings.

 

(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Item 2(a) through (d) are inapplicable.

 

(e) Stock Repurchases

 

The following table sets forth ADTRAN’s repurchases of its common stock for the months indicated. All shares were purchased in open market transactions.

 

Period


  

(a) Total

Number of
Shares
Purchased


   (b) Average
Price Paid
per Share


   (c) Total Number
of Shares
Purchased as Part
of Publicly
Announced Plans
or Programs (1)


   (d) Maximum
Number of Shares
that May Yet Be
Purchased Under
the Plans or
Programs


April 1, 2004 – April 30, 2004

   323,400    $ 24.86    323,400    4,000,000

May 1, 2004 – May 31, 2004

   173,500    $ 24.96    173,500    3,826,500

June 1, 2004 – June 30, 2004

   —        —      —      3,826,500

Total

   496,900    $ 24.89    496,900     

 

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(1) On July 16, 2001, ADTRAN announced that its board of directors approved the repurchase of up to 2,000,000 shares of its common stock. With the repurchase of the 323,400 shares in April 2004, ADTRAN completed this share repurchase plan. On April 29, 2004, ADTRAN announced that its board of directors approved the repurchase of up to 4,000,000 shares of its common stock. In May 2004, 173,500 shares were repurchased under this share repurchase plan.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

The 2004 Annual Meeting of Stockholders of ADTRAN was held on April 15, 2004. Proxies with regard to the matters voted upon at the Annual Meeting were solicited under Regulation 14A of the Securities Exchange Act of 1934, as amended. Set forth below is a brief description of each matter voted upon at the Annual Meeting and the results of the voting on each such matter:

 

  (a) Election of each director named below to serve until the next Annual Meeting of Stockholders. There was no solicitation in opposition to any of the nominees listed in the proxy statement, and all of the nominees were elected.

 

     Votes

Nominees


   For

   Withheld

Mark C. Smith

   73,628,167    803,824

Howard A. Thrailkill

   73,181,237    1,250,754

Richard A. Anderson

   72,230,965    2,201,026

W. Frank Blount

   73,243,764    1,188,227

H. Fenwick Huss

   73,319,099    1,112,892

William J. Marks

   72,798,336    1,633,655

Roy J. Nichols

   73,382,349    1,049,642

 

  (b) Ratification of the appointment of PricewaterhouseCoopers LLP as its independent registered public accounting firm for 2004.

 

Votes


For


  

Against


  

Abstain


72,876,137

   1,553,350    2,504

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a) Exhibits.

 

Exhibit No.

  

Description


31   

Rule 13a-14(a)/15d-14(a) Certifications

32   

Section 1350 Certifications

 

(b) Reports on Form 8-K

 

On April 14, 2004, ADTRAN, Inc. furnished a current report on Form 8-K announcing its financial results for the fiscal quarter ended March 31, 2004 and certain other information.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

    

ADTRAN, INC.

    (Registrant)

Date:  August 05, 2004

  

  /s/ James E. Matthews


    

James E. Matthews

    

Senior Vice President - Finance and

    

Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description


31    Rule 13a-14(a)/15d-14(a) Certifications
32    Section 1350 Certifications

 

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